The Promise of Financial Inclusion
What do we mean by financial inclusion and why does it matter?
Financial inclusion gets to the heart of our mission here at Vaya. It’s one of three concepts that I often use to describe our work to our customers, partners, investors as well as to our team [^1]. But sometimes I get the feeling that I should be more clear about what I’m talking about. Here, for example, is an only slightly edited conversation I had with the Vaya team recently.
Me: “When I say financial inclusion, you all know what I am talking about right?”
Team Member: Sure. It means helping small businesses get loans...
Me: Ok, thats a start, but is that it? Why do small businesses even need help getting loans? And why do we call this financial inclusion?
Team Member: <Insert Dog Ate Homework Look>
In this post then, let me try to clarify what I mean when I say financial inclusion and why this matters to all of us. I'll cover the three points below to try and make the abstract concept more a bit more tangible.
1. 📏 Measuring Financial Inclusion. As always, I’ll start with the stats so we can level set on how people typically talk about this concept.
2. 🤝🏽 The Promise of Inclusion. Then, we’ll considering the typical financial transactions we do all the time and the benefits of using our bank accounts.
3. 😱 The Perils of Exclusion. Finally, I'll ask you to consider how difficult those typical financial activities might be if you weren’t part of the financial system.
In the next post, I’ll cover why some people choose to opt out or find themselves excluded and what the implications are for the small businesses we make it our mission to serve.
📏 Measuring Financial Inclusion
If you google or chatgpt financial inclusion, you’re likely to get an answer in terms of what percentage of the population has a bank account or are banked.
Growing up in the US, I thought that pretty much everybody had a bank account, and that financial inclusion was mainly a low or middle income country problem.
The numbers more or less support that view. Across High Income Countries, over 95% of the population has a bank account compared to roughly 50% of the Middle East, North Africa and Sub Saharan Africa, 70% of South Asia and Latin America, 80% of Europe, Central Asia and East Asia [^2].
The problem though is that while having a bank account is a good place to start talking about financial inclusion, its not a particularly good place to stop. For example, why would people with bank accounts still continue to use non-bank financial institutions for services that you would typically get at a bank like foreign remittances, payments to their friends, or loans?
Another metric – called underbanked – gets at this idea. It measures the percentage of the population that has a bank account but still uses alternative financial services from something other than a bank for services that you would typically get at a bank [^3]. It’s a more comprehensive metric for high income countries like the United States where we work.
Through the lens of the underbanked metric, I was surprised to find that maybe financial inclusion remains a significant challenge after all. In the United States, while just 5% of the population is unbanked, around 15% of the population is underbanked[^4]. In other words, about 20% of Americans are either not able to access some or all critical services that banks provide [^5].
While having a bank account is a good place to start talking about financial inclusion, its not a particularly good place to stop. In the United States, about 20% of Americans are either not able to access some or all critical services that banks provide.
🤝🏽 The Promise of Inclusion
So let’s talk next about why it even makes sense to talk about banks when we talk about financial inclusion. As a first step, try to imagine the typical financial transactions in your own life over the course of say a month. Here’s what that looked like for me:
I bought stuff – sometimes online and sometimes in person. I bought office supplies on Amazon. I paid for a meal at a restaurant. (Payments)
I paid a bunch of bills including the usual stuff like power, internet and phone but also for health and life insurance premiums.(Bill Payments, Insurance)
I transferred money to and from friends and family – sometimes across international borders, sometimes just between my own accounts. I received my income (Transfers)
I made loan payments for the mortgage on our house and whatever was on the credit card. (Loans)
I saved money into a bank account. (Savings)
I invested into brokerage account. (Investments)
And I did all of these using my bank account pretty quickly and painlessly either directly or through some service or app that was using my bank in the background. I would be surprised if your list didn’t also include some mix of these basics: payments, transfers, loans, savings and investments.
If you plug into the formal financial system through a bank account you can do basic things that you need to do with money safely, quickly, cheaply and – for the most part – conveniently. This is the promise of inclusion.
The promise of inclusion is that if you plug into the formal financial system through a bank account you can do basic things that you need to do with money safely, quickly, cheaply and – for the most part – conveniently.
😱 The Perils of Exclusion
Now try to imagine doing any of these things without a bank account. This can be pretty hard to do if you've used banks your whole life, so it might help to remind yourself of the last time you were traveling or living in a foreign country. I remember not really getting it until I moved to India few years ago and tried to get on with just having cash. (It didn't help that my experience coincided with the Indian government cancelling much of its currency in circulation, but that's a whole another story![^6])
If you're able to get your mind to imagine a world without banks or decentralized equivalents in the crypto world, you’ll start to get an idea of the perils of being outside of the formal system.
Consider payments for example.
How would you buy anything online if you didn’t have a card of some kind? You probably wouldn’t. Instead, you'd have buy stuff in cash. Prior to the payment you'd be worried about getting cash in the first place, then about losing your money or getting it stolen, having to have exact change, and so on.
Then after the payment you usually won't have a record of the transaction without which you'll have a hard time with returns or building eligibility for a credit card down the road. On top of all of this, there is loss of your time to go and pay for things in person. Your other option is to use bank alternatives to send money. But you'll still have to go somewhere, hand over your cash, pay hefty fee, and hope the money reaches the person you are sending it to.
What about crypto? The overall the evidence on crypto's impact on inclusion so far is at best mixed [^7]. And anyway, the onramp to crypto currencies is usually a bank account from which you can use normal (fiat) money to buy crypto currencies. Digital, closed-loop wallets like Cash App or Venmo are also typically supplements to -- rather than replacements for -- banks for the same reason.
In other words, none of this is especially safe, quick, cheap or convenient.
It's gets worse if you think about getting a loan: how would that work?
You're basically be limited to asking friends and family who already know and trust you since you don't have any real proof of your income (typically in the form of a bank statement) that a formal institution would accept. So now your stuck with loan sharks, payday lenders or pawn shops that have high costs or require you to surrender whatever assets you may have.
Even if you could convince a family member or local loan shark, how much could you possibly borrow? Given the recent study showing that a third of Americans wouldn't be able to come up with the $400 in cash for an emergency [^8], probably not enough to buy a house or fund your education.
I'll leave you with the take home exercise to consider the challenges of saving, investing and insurance outside the formal financial system where the ticket to entry is basically a bank account.
My point here is that financial services outside the formal system – those outside of banks or alternative financial services – are generally less safe, more expensive, slower and usually more inconvenient. This is why the financial inclusion metrics have to do with whether you have a bank account and whether you use it.
Financial services outside of banks and the formal system – alternative financial services – are generally less safe, more expensive, slower and usually more inconvenient.
All of which begs the question that if banks and the formal financial system is so great, why are 20% of Americans left out or choose to opt out? I’ll tackle that in the next post.
Soham Sen is Co-Founder and CEO of Vaya Technologies. If our mission resonates with you, please get in touch, checkout our open positions here, and consider signing up for our substack to receive new posts in your inbox.
Footnotes
[^1]: The other two concepts are embedded credit and fintech infrastructure. They are more about how we achieve our mission – more on these two later.
[^2]: The World Bank’s Global Findex 2021 along with my calculations. Note that high income countries are excluded from the regional averages mentioned here. https://www.worldbank.org/en/publication/globalfindex/Data
[^3]: There are actually other, more expansive ways of thinking about the underbanked as one of our favorite bloggers, Alex Johnson has written. In addition to the traditional definition of underbanked that I describe here, one might also consider the negative space of bank services. That is to say, the underbanked could include all those folks whose financial needs are not being met by the bank today for which alternative services -- expensive, risky or otherwise -- also do not exist.
[^4]: In the US, the FDIC Survey of the Banked and Unbanked surveys households. https://www.fdic.gov/analysis/household-survey/index.html
[^5]: In comparison, the unbanked rate is about 2% in the UK and the underbanked percentage is about 6%. This is from the UK Financial Lives Survey 2020 by the FCA p116 https://www.fca.org.uk/publication/research/financial-lives-survey-2020.pdf. Note that the UK does not have an exactly analogous concept as underbanked; I’m referring to the percentage of folks who were refused one or more financial products like credit cards, loans or overdrafts.
[^6]: https://en.wikipedia.org/wiki/2016_Indian_banknote_demonetisation
[^7]: The argument is sometimes made that maybe crypto currencies can be or already are an alternative to the formal banking system, but so far this does not seem to be the case. https://www.brookings.edu/articles/debunking-the-narratives-about-cryptocurrency-and-financial-inclusion/